Nasdaq and S&P 500 rise as Nvidia leads recovery from CPI sell-off

Following higher-than-expected inflation figures on Wednesday, markets are quickly pricing in a higher probability that the US Federal Reserve will decide on a small interest rate cut at its September meeting.

Markets sold off after news that the Fed will not cut interest rates by 50 basis points as some had hoped. The S&P 500 (^GSPC) and Dow Jones Industrial (^DJI) fell more than 1.5% within two hours of the report before recouping some losses.

However, some strategists believe a 25 basis point cut would be a more welcome signal from the Federal Reserve.

Eric Wallerstein, chief market strategist at Yardeni Research, concluded that the Fed was unlikely to cut interest rates by more than 25 basis points “unless a recessionary situation occurs or a financial crisis looms.”

“Anyone calling for a 50 basis point cut, I think, should think again about how much volatility that would cause in the short-term funding markets,” Wallerstein told Yahoo Finance. “That’s just not something the Fed wants to risk.”

Wallerstein’s argument: While the latest jobs report continued to show signs of a slowdown in the labor market, economists widely argued that the August jobs report did not reveal the significant slowdown that many thought was needed to prompt a deeper Fed cut. The same goes for the August consumer price index (CPI), which showed prices rising at their lowest annual level since early 2021.

But the details of the report showed that on a “core basis”, that is, excluding the more volatile costs of food and gasoline, prices rose 0.3 percent in August from the previous month, above Wall Street expectations for a 0.2 percent increase.

“The unfortunate news on inflation will distract somewhat from the Fed’s renewed focus on the labor market and make it more likely that officials will stick with a more dovish approach to easing, starting with a 25 [basis point] next week,” Michael Pearce, deputy chief U.S. economist at Oxford Economics, wrote in a note to clients on Wednesday.

Further clues about what the Fed thinks the rate-cutting cycle will look like will be provided on September 18, when the Federal Reserve releases its summary of economic forecasts, including its “dot plot” showing policymakers’ expectations for future interest rate developments.

As of Wednesday morning, markets have been expecting the Federal Reserve to cut interest rates by 100 basis points this year. Wallerstein argued that it would not necessarily be bad for stock prices if the total amount of Fed rate cuts this year fell short of market expectations.

“If these rate cuts are no longer possible because growth is stronger than expected, GDP is strong in the third quarter, labor market indicators are not too bad and we continue to see an increase in consumer spending, [increasing]then stocks have more room to move higher as earnings continue to grow,” Wallerstein said.